Key Audit Matters gives insight into what’s on an auditor’s mind

For years, a common complaint from shareholders was that the auditors’ report didn’t share much.

Unless there was a qualification to the accounts, the auditors’ extensive efforts seemed to add up to a simple yes/no on the issue of whether the accounts represented a true and a fair picture.

Last year in Australia, that state of affairs changed. Standard-setters brought in the so called ‘enhanced’ audit reports, adding tailored narratives of the issues which required most attention during the audit: Key Audit Matters (KAMs). This is now obligatory and today KPMG issues an analysis of the first year’s activity among ASX200 companies with 30 June 2017 year ends.

The major finding of the first year of adoption, with 128 ASX 200 companies having released their reports, is the majority of KAMs concern the values, and possible impairments, of goodwill and associated CGU assets.

Sixty three percent of audit reports included KAMs relating to goodwill. The next, revenue (29 percent), taxation (20 percent) acquisitions (also 20 percent) and inventory (19 percent) were a long way behind.

No surprises here. Companies are obliged to test goodwill annually for impairment and not only are the numbers involved large, but the forward-looking estimations in these models require a lot of judgement. This is especially so in challenging economic conditions.

In our report we also found that in 25 percent of cases there was an impairment charge booked. Sectors most impacted included:

Revenue KAMs were common in Real Estate, where increased audit attention was needed on assessing stage-of-completions estimations common in the property industry’s revenue recognition policies. They were also prevalent in Consumer & Retail on issues like bespoke customer contracts, and multiple IT systems collating high volume transactions.

Consumer & Retail also saw a lot of KAMs to do with acquisitions – this is consistent with KPMG’s observations where opportunity for portfolio acquisition strategies are greater in an economic environment driven by digital disruption and the data explosion.

Around 90 percent of the companies with acquisition KAMs also communicated a goodwill KAM – which could suggest the goodwill recorded from previous competitive acquisitions is now at risk of a write-down, and so will attract auditors’ attention.

One of the most interesting categories of KAMs involved taxation, which featured in approximately a third of entities in the Energy and Natural Resources (ENR), Infrastructure, Government and Healthcare and TMT sectors. In almost 60 percent of these sector KAMs, auditors were concerned with assessing the recoverability of deferred tax assets, which is judgemental based on the likelihood of future taxable profits.

In ENR, the risk of inaccurate forecasting is greater given the recent industry experience of fluctuating commodity prices increasing the range of possible outcomes.

It seems likely that the increasing calls locally and internationally for greater tax transparency have given rise to additional attention by companies and their auditors. Given the complexities of areas like transfer pricing, it is not surprising that 60 percent of the taxation KAMs in those sectors communicated the involvement of tax specialists.

I believe the enhanced audit report is the biggest change that auditors have experienced. Feedback from companies, shareholders and analysts so far has been largely positive and it will be interesting to see what the forthcoming AGM season brings as more stakeholders get to grips with the new report for the first time.

In opening up the audit ‘black box’ and demonstrating what areas the auditors believed most needed attention, KAMs add real value. It shows to all interested parties information that was previously the exclusive preserve of the boardroom.

Thanks Carolyn, this was very interesting as it reflects the changing nature of our client’s business models. Our non-audit clients can learn from this information too. In particular the impairment change in TMT and Consumer markets driven by changes in delivery channels and new technologies.